Colin Barry

Valuation Lecture (BAV, Tuesday, Week 6)


"I hope you had enough coffee --- this is going to be awesome." -- F. Brochet, before launching into lengthy discussion of valuation

Traditional valuation methodologies:

Measures available cash flow to equity (dividends or repurchase): (Net Income) -- (Changes in Book Value of Net Op Assets) -- (Changes in Book Value of Net Debt)
Projects future performance (How far? Depends on maturity of firm...)
Terminal Value => often 70 or 80% of firm's value
Discount rate => sensitive to assumptions, basic CAPM should work but hard to find comps and several empirical challenges (size, book/market, momentum)

Simple; usually a good starting point
Need good judgment in selecting peer; usually hard to figure out "real" peers
Sensitive to non-recurring items, temporary performance blips, etc.
M&A premium --- how do we think about it?

An alternate methodology:

-- Depends on semi-strong market efficiency (price reflects all publicly available data)
-- Rejects "greater fool theory" and industry-practice (everyone uses 12x EBITDA, so doing anything else actually imposes risk)
-- Fundamental problem with dividend discounting valuation methodologies --- namely, most public companies don't actually pay dividends!
-- Problem with DCF: capturing all flows is tricky, usually ends up being a more complicated version of multiples because terminal value is huge and hard to estimate

So, assume that "abnormal earnings" (above equity cost of capital) will eventually revert to the mean.

Still problems with abnormal earnings valuation: accounting data may need adjustment, off-balance sheet items not obvious, assumes "clean surplus" (where all changes in equity value flow through the income statement)